Optimism for earnings in this sector.
Even amid global trade tariffs, geopolitical headline risk and decelerating global industrial production, the Industrial Select Sector SPDR (ticker: XLI) exchange-traded fund gained 27% in 2019, roughly in line with the overall market. Heading into 2020, the United States-Mexico-Canada Agreement and a preliminary Phase One trade deal with China have created some clarity for the industrial sector that could generate tailwinds for production and earnings. In addition, after a slow year for mergers in 2019, industrial consolidation could be on the rise this year. Here are seven top industrial sector stock ideas from the Morningstar analyst team.
Guangshen Railway Co. (GSH)
Guangshen Railway is a key railroad operator in Chinaâ€™s Guangdong province. Analyst Jennifer Song says slower economic growth and rising competition in China are near-term challenges, but the stock is undervalued at only around 0.5 times book value, a 38% discount to its long-term average. Song says investors should monitor the potential negative impact of new high-speed rails and growing traffic networks in China, but Guangshen is still on track to grow profits by 23.5% annually over the next five years. Morningstar has a â€śbuyâ€ť rating and $34 fair value estimate for GSH stock.
Herc Holdings (HRI)
Herc Holdings is one of the largest U.S. equipment rental and service companies, holding about 3% North American market share. Analyst Scott Pope says Herc has â€śsignificant upsideâ€ť due to its recently expanded offerings. Pope says Hercâ€™s model of placing personnel and equipment permanently on location for its largest customers helped generate more predictable and smooth recurring revenue and lower sales costs. In addition to its core business, Herc expanded into more specialty equipment, such as television and film studio equipment. Morningstar has a â€śbuyâ€ť rating and $58 fair value estimate for HRI stock.
Lyft investors are happy for the calendar to flip to 2020 after a disappointing debut year. Shares are down about 37% from its 2019 initial public offering price, but analyst Ali Mogharabi says patient investors will ultimately be rewarded. While large losses have spooked Wall Street, Mogharabi says Lyft is actually gaining market share in a ridesharing market that could ultimately be valued at $500 billion. He also says Lyftâ€™s goal of reaching profitability by the fourth quarter of 2021 is within reach. Morningstar has a â€śbuyâ€ť rating and $72 fair value estimate for LYFT stock.
Terex Corp. (TEX)
Terex manufactures construction and mining equipment. The companyâ€™s aerial work products, including its Genie brand, account for nearly two-thirds of its revenue. Pope says long-term trends toward aerial devices and global infrastructure spending should be tailwinds, but the stockâ€™s near-term outlook is challenging. Terex has guided for a 10% drop in revenue in 2020, but improvements in China could help offset this weakness. Pope says Chinese customers seemingly prefer Western brands to domestic equipment, potentially due to higher workplace safety standards in the West. Morningstar has a â€śbuyâ€ť rating and $36.50 fair value estimate for TEX stock.
Uber Technologies (UBER)
Uber investors shared in Lyftâ€™s woes in 2019, with the stock finishing the year down nearly 33% from its IPO price of $45. However, Mogharabi says Uberâ€™s weakness is a buying opportunity for patient investors willing to ride out the companyâ€™s growing pains. Mogharabi says investors shouldnâ€™t be concerned about former CEO Travis Kalanick recently dumping all of his shares in the company. Instead, he says Uberâ€™s fate lies in its ability to demonstrate a profitable rideshare business model by around 2024. Morningstar has a â€śbuyâ€ť rating and $58 fair value estimate for UBER stock.
United Rentals (URI)
United Rentals is the worldâ€™s largest equipment rental company and operates nearly 900 locations in North America. Pope says United is a â€ścompelling investment opportunityâ€ť and its $14 billion in equipment and leading 13% North American market share give it scale advantages in a generally fragmented market. Thanks to an acquisition spending spree, specialty rental revenue is up 34% annually since 2012 and now makes up 21% of total revenue. Pope says management must continue to optimize its equipmentâ€™s cost of ownership. Morningstar has a â€śbuyâ€ť rating and $185 fair value estimate for URI stock.
Wesco International (WCC)
Wesco is an electrical, industrial and communications equipment maintenance provider. Wesco is in a unique situation among its industrial peers in that it is entering 2020 as a potential near-term buyout candidate. In late December, private equity firm Clayton, Dubilier, and Rice reportedly made an offer to acquire Wesco for an undisclosed amount. Analyst Brian Bernard says Wesco shares currently trade at a significant discount to fair value, and the Wesco board made a good move by rejecting the likely lowball offer. Morningstar has a â€śbuyâ€ť rating and $86 fair value estimate for WCC stock.
Top-rated industrial stocks to buy:
Guangshen Railway Co. (GSH)Herc Holdings (HRI)Lyft (LYFT)Terex Corp. (TEX)Uber Technologies (UBER)United Rentals (URI)Wesco International (WCC)